If a remodeling company wants to stay in business, it must know and understand its break-even sales volume. This is the amount a company must produce and sell to cover its overhead. This is neither a profit or a loss, just the price of staying afloat.
“Accurately forecasting can be kind of risky because as remodelers, we’re risk takers,” says Dan Mackey, CR, CKBR, GCP, CGBP, president of Daniel Mackey Construction, Inc. a design/build remodeler in San Jose, Calif.
“When we predict that a job is going to take 10 hours, and we do it in eight we make a little bit of money, but those times when it takes 12 or 14 hours, when we’re working at our break-even pricing, then we’ve lost money on the job.”
To figure out a company’s break-even sales volume, management has to know what its costs are. That is figured out by tracking all of the company’s expenses such as labor, insurance, associated office costs, licenses, taxes, etc. — essentially all of the things that it takes to stay in business over the course of the year. From that a company can extract the minimum costs for doing a job and know what amount it will need to make from that job. With fluctuating costs and overhead, this should be monitored from year to year. However, working at a break-even number doesn’t allow any room for error.
One way to factor in error into a job is to look at the company history and figure in slippage to the break-even number. In other words, when a remodeler consistently bids X amount of money on a job, but comes in at a less amount, then they’ve got that percentage as their slippage and that has to be factored in.
Besides staying afloat, knowing the break-even sales volume is important during highly competitive times like now. With more companies trying to grab smaller amounts of work, they have to know just how low they can go on prices to be competitive. Quality and service will always be a determinant for hiring a remodeler, but for a lot of people, the bottom line is price.
“Knowing my break-even sales number has helped in running my business,” says Mackey. “We know when we have a need to hire more workers, and it also tells us when we might have to lay somebody off. Your sales volume has to drive all of your financial decisions.”
Calculating Break-even Sales Volume
To calculate a company’s break-even sales volume, there are a couple of formulas to know. The first is for the Contributions Margin. This is important to know before calculating the break-even sales volume. As seen in Figure 1, the Contributions margin is the “selling price less the variable costs per unit.” In essence, it is the amount of money the sale of each unit or project will contribute to covering total fixed costs. To clarify variable costs, that is the amount it costs to buy or create the product that is being sold. Variable costs can include raw material costs, direct labor, sales commissions, freight costs, packaging and energy costs (fuel, electricity, etc.) associated with producing a remodeling project.
Figure 1: See piture on the right
Now that the Contributions Margin is known, the break-even sales volume can be figured out. To calculate this you will now need to know what your annual fixed costs are. The fixed cost is the costs of being in business, namely the company’s overhead. These costs don’t vary with the level of output of a remodeling company and would be incurred if production were to cease. This includes rent, insurance, depreciation, salaries, property taxes and any other costs that aren’t directly associated with production of a project.
To figure out the break-even sales volume number then, it is a matter of dividing the total annual fixed costs by the contributions margin (see Figure 2). So if a company’s total annual fixed cost is $100,000 and its contributions margin is $2,000, the company would have to complete 50 jobs in order to break even at the end of the year. This also means that if the total fixed cost is $100,000 and its contributions margin is $5,000, it will only have to complete 20 jobs to break even. So the higher the price of the job, the smaller the quantity of work will be needed to break even; however, at higher prices, it can be more difficult to sell, especially with the high level of competition currently in the market.
Figure 2: See piture on the right
The last formula to keep in mind is when a company actually wants to factor in a profit into their business (see Figure 3). To calculate that, a company first needs to figure out what its profit objective is. Let’s say a company has a capital investment of $100,000 and wants to earn a 10 percent return on the investment. That means that the company will require a $10,000 profit to reach its objective and can be viewed as a fixed cost of doing business. To integrate this into the equation, the profit dollar amount is simply added to the total annual fixed costs and when computed will output the break-even sales volume plus a profit .
Figure 3: See piture on the right